Tax Talk: Virtual or cryptocurrency is treated as 'property' by the IRS

Rick Klee

Ken Milani

While filing my income tax return using software, a question about virtual currency was asked. Can you write a column about income tax outcomes related to virtual currency?

— RM, email

Virtual currency is also known as cryptocurrency. According to most financial historians, digital currency began to gain traction in the last 15 years and its growth has been impressive. We’ll turn to a February 2022 Reader’s Digest article, “Our Two Cents on Cryptocurrency” (pages 28-31) for a succinct – and somewhat understandable – summary of this new form of payment which is sold by companies such as Bitcoin, Ethereum, Binance Coin, Coinbase, Dogecoin, Tether and others. Quoting the Reader’s Digest original article:

“Most cryptocurrencies work using block-chain technology, a type of data base that serves as a permanent ledger for transactions . . . their value is based on the activity of their users. The more ‘coins’ people buy, the more those coins are worth. . . . One way to earn cryptocurrency is through mining but it’s an intensely complicated process that releases new coins into circulation using advanced computer equipment (just like other mined materials, the total amount of some cryptocurrencies is finite.) So the way most people get their cryptocurrency is by buying it on online exchange platforms. . . . Businesses that allow customers to pay with crypto include PayPal, Tesla and Xbox . . . . Even . . . charities, including The Water Project, The Red Cross and Save the Children, accept donations made in cryptocurrency.”

Merriam Webster states that crypto “. . . has no central issuing or regulating authority but instead uses a decentralized system to record transactions and manage the issuance of new units, and that relies on cryptography to prevent counterfeiting and fraudulent transactions.”

Don’t underestimate the IRS’ interest in cryptocurrency. Look at the very first question under your name and address — “At any time . . . did you receive, sell, exchange or otherwise dispose of any financial interest in any virtual currency?” So, if you choose to invest in this volatile asset, be sure you receive proper documentation from the crypto company to determine gains and losses mentioned later in this column. There are crypto tax specialists helping folks who are very active in trading virtual currency. While the pandemic has slowed their efforts, the IRS began an active Virtual Currency Compliance Campaign before Covid. Check out www.irs.gov for help with “Frequently Asked Questions on Virtual Currency Transactions.”

Crypto and taxes

As for the income tax outcomes, virtual or cryptocurrency is treated as “property” by the Internal Revenue Service. As you read this column, the IRS is working on a set of provisions that address this newcomer which is pitched by Matt Damon in TV ads, provides comedy material for “Saturday Night Live” and perplexes many (including your columnists) who aren’t sure what it’s all about.

The IRS stance (i.e, cryptocurrency is property) treats gains and losses as capital in nature. Thus report gains as either short-term or long-term capital gains. Since any “property train” runs both ways, cryptocurrency losses show up on a Form 1040 as either short-term or long-term capital losses. Next week’s column will concentrate on the tax treatment of capital gains and losses. At this point, we’ll take the “Reader’s Digest” route – Net Short-Term Capital Gains are taxed like ordinary income; Net Long-Term Capital gains receive preferential tax treatment; Net Capital Losses face stringent rules which may limit their ability to offset income or gains on a 1040.

One thing for sure, Superman will never use cryptocurrency! WHY? Cryptocurrency sounds too much like Kryptonite which is Superman’s Achilles Heel!!

Ken & Klee’s income tax bulletin board. A recent article in “Forbes” reports the top 10 cryptocurrencies have a total market capitalization (i.e., value of all cryptocoins in circulation) of over $1.5 billion with the two leaders, Bitcoin and Ethereum, making up over 75 percent of that total. You can gauge the growth of the virtual currency business by looking at what is happening in Washington, D.C. A public advocacy group’s recent report indicates the number of crypto lobbyists has tripled in the last 3 years. Last week, saw President Biden issue his first executive order to study digital currencies and consider additional regulations.

Rick Klee served as the tax director at the University of Notre Dame from 1998 through August 2019. A retired CPA, Klee is a graduate of Notre Dame. You can contact him at rklee@nd.edu.

Ken Milani is a professor of accountancy at Notre Dame where he served as the faculty coordinator of the Notre Dame Tax Assistance Program. Contact him at milani.1@nd.edu. E-mail questions to either.

This article originally appeared on South Bend Tribune: Taxes 2022: Crypto is treated as ‘property’ by IRS

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